The early days of Quantitative Finance

A lot of people start studying Quantitative Finance because they see it as a great way to earn money. It seems indeed reasonable that somebody with great mathematical skills would be looking for opportunities allowing him to make a profit — sometimes at the expense of others. I can still remember like yesterday seeing a friend — clearly one of the smartest persons I’ve met — losing money at a roulette table being certain that he had a winning strategy (!) as well as countless classmates claiming they could easily make a profit out of the stock market.

Nowadays, we have books about it, computers to help us and well-known strategies which make it always more difficult to make long-term risk-adjusted profits because all available opportunities are quickly taken away by sophisticated investors.

But how did it work in the old days? Who were the first people to study the field? When did it start? How did they put it in place? Did they make a fortune? Are they still making a fortune? All these questions are fascinating to me, and I just finished reading up a book called Fortune’s Formula by William Poundstone which addresses these topics.

Obviously, this book does not contain any fortune formulas, but it depicts the stories of the men who contributed to the field in the early days. This book was fascinating because it talks about some very important “discoveries” such as the Kelly criterion, based on Information Theory, Modern Portfolio Theory, Market Efficiency and how these techniques were put to practice at the very beginning. It also talks about how the first formula to price warrants was discovered and the struggles through which Edward Thorp went before he could really make money out of it — and how it all ended. We also learn how some brilliant minds — Noble Prize winners — got caught and lost everything in the LTCM collapse.

The good thing about this book, is that it explains all this in relatively simple words. Indeed, Poundstone focuses on the concepts rather than on the technicalities and puts everything in historical context such that any interested reader can go through the pages without being lost in details.

If you’re planning to go on holidays at the end of the year and you’re looking for a good book to read, I strongly recommend this one.